There are few things more intimidating than preparing for retirement. We're bombarded with opinions, many of which contradict each other. The best we can do is create an inventory of what we want our retirement years to look like and figure out how much money it will take to finance our "dream" retirement.
Is there a magic number?
Estimates vary, but most financial experts say you should invest enough money for retirement so you can replace 75% of your current salary. Here are some of the reasons retirement planners say 75% should be enough.
- You will no longer have work-related expenses. You won't be filling the car with gas to get to and from work, and you won't need to buy work clothes. If you eat lunch out on work days, you can also cut this expense out of your monthly budget.
- You won't have to save for retirement anymore. If saving for retirement has eaten up a large portion of your income, that's money you'll no longer need to shell out.
- Your taxes are likely to decrease. Paying a lower tax rate also leaves more money in your checking account each month.
These last two reasons may or may not apply to you:
- Experts assume that you'll no longer have dependents at home to support. If you're caring for a disabled adult child or raising your grandchildren, you'll want to replace more than 75% of your current income.
- Experts also assume that you won't have debt to pay off. If, like millions of people, you'll still be paying rent or a mortgage payment, you may also want to replace more than 75% of your income.
75% of $50,000
75% of $50,000 is $37,500. That's the gross amount you'll want to bring in each year. In 2023, the average monthly Social Security payment is $1,827. As an illustration, let's say you'll receive Social Security (or a pension), and your checks will be $1,827 each. Multiplied by 12, you've already covered $21,924 of the $37,500 you need.
That leaves you with a $15,576 gap.
Filling the gap
In 1994, a financial adviser named William Bengen created the 4% rule. According to Bengen's theory, retirees should be able to make their retirement funds last for 30 years by withdrawing no more than 4% per year.
Let's say you have $400,000 in a 401(k), savings account, or other investment account. If you withdraw 4% annually, you'll have an extra $16,000 -- just enough to cover the $15,576 gap. What's more, the 4% rule calls for tweaking how much you withdraw each year based on the inflation rate. As inflation increases, so does the amount you withdraw.
However...
Bengen's 4% rule has undoubtedly helped countless retirees determine how much they can safely withdraw each year. However, it may no longer fit the realities of retirement. The rule doesn’t consider the wide variety of retirement plans. For example, one person may want to jump a freighter and travel the seas, while another wants to hunt and fish with friends. In other words, there’s no one-size-fits-all retirement budget.
The rule also fails to consider factors like inflation, portfolio composition, potential medical expenses, and taxes. In other words, 4% only works for some and may not work for you.
A better plan?
Morningstar's "The State of Retirement Income: 2022" found that we'd all be better off with a starting withdrawal rate of 3.8%. Two-tenths of a percent difference may not seem like much, but by lowering the withdrawal rate, retirees can stretch their funds.
So, how does that affect your scenario? We know that receiving an average monthly Social Security or pension check of $1,827 provides $21,924 of the $37,500 needed to replace 75% of $50,000, leaving a $15,576 gap.
If you have a retirement fund of $420,000 and withdraw 3.8% annually, that would bring in $15,960 -- enough to cover that gap.
You may want more
You may need more than $37,500 to live the retirement life you're looking forward to. Here's how much you'll need to have put away (in investments, personal savings, and guaranteed income like Social Security, a pension, or an annuity) if you'd prefer to have more money in retirement. We're still assuming that you'll receive $21,924 from retirement benefits.
| If you want an annual gross income of: | You'll need this much put away for retirement: |
|---|---|
| $39,024 | $450,000 |
| $42,824 | $550,000 |
| $46,624 | $650,000 |
| $50,424 | $750,000 |
| $54,224 | $850,000 |
| $58,024 | $950,000 |
Data source: Author's calculations
The earlier you begin investing, the longer compound interest has to grow your money. But it's also essential to know it's never too late to start. If you're staring down retirement and afraid you're not ready, consider working longer to build your retirement account. Or look into working part-time after retirement doing something you enjoy.
Once you know what you want to do throughout your golden years, you can come up with a number to aim for. If you need help figuring out where to begin, take the leap and speak with a financial advisor. Look for one who works for a flat fee and will advise you without pushing investment products on you.
